This is a question that was posed to us. It is being published in 'It's Up to You', the monthly publication of The Kobrin Agency Inc.".
May 14, 2003
"Ron, portfolios have been decimated. Should we sell everything...invest in real estate... or go into pure safety? Or- none of the above?"
Lately, when speaking to investors new to our firm, we almost always hear the comment "everyone lost money over the last few years." That is a fallacy. We manage over 300 portfolios at Redfield, Blonsky, and none of our portfolios got "decimated.” Some keys to investing are discipline, knowledge of the investment, time, understanding of risk, proper research and diligence, constant doubt (one of the most important ingredients) and patience. With that said, "Should we sell everything?” Generally speaking, that would be a rash move and should generally be avoided. What generally needs to be done is an immediate evaluation of the portfolio along with an evaluation of the investor, the investor’s needs and the investor’s tolerance of risk. We often find that the investor’s tolerance for risk is not congruent to their investment needs. For example, we have seen investors who claimed they needed returns of 10 % a year to meet their living requirements. These investors adjusted their portfolios and claimed to understand the risk levels of such returns (keep in mind that 10 % returns were scoffed at as being too low several years ago). What the investor and very often the advisor to the investor didn't take into account is the "what-if there were losses." We would often explain to a client, that although they desired and could psychologically tolerate certain risks, they could not afford the consequences that could accompany those risks. Hence, a focused, balanced and defensive portfolio is generally the key for giddy times. So, the short answer is "no, you should not immediately sell everything, but you should immediately have your portfolio evaluated by a competent professional."
Steve, you also asked about investing in real estate. We are hardly real estate professionals, and we always emphasize that in our investment discussions with clients or investors. Real estate is such an important part of our lives, and it often exists as a major part of a portfolio, even though the investor doesn't realize it. Let's use an example of an investor with a portfolio worth $250,000, a 401k worth $150,000 and a house worth $600,000 with a mortgage of $200,000. In this example the investor has a net worth of
$800,000, where as the house makes up 50 % of the portfolio. Typically, our clients and people we speak to, do not factor their residence into the portfolio allocation mix. Of course the residence should be part of the portfolio mix, heck in this instance it is 50 % of the net worth. With the understanding that we are not real estate professionals, we do believe that the real estate market is in a severe overvaluation phase. We feel that any of a few factors could pierce the valuation of homes. These factors could include rising interest rates, rising or continued higher unemployment or a re-evaluation of traditional measures of valuing real estate. Again, we would not "sell everything" and go into real estate. People need to realize that real estate is generally a very long-term investment, and its primary purpose should be for shelter. When our clients are buying real estate, we ask that they evaluate the cash flows, operating costs, expected outflows and such. Interestingly enough, we were very positive on investing in real estate in the early 1990's. Here in the Northeast we saw home prices fall from the peaks of the '80's and there were incredible opportunities in real estate. We do feel that those opportunities will exist again. Real estate at this point reminds us of the NASDAQ mania of the late 1990's, yet I mention again (and again, and again) that we are not real estate professionals. I will often hear a client say " Ron, we have heard that from you for over a year now. You are wrong about your views on real estate." My reply often will be, "Do you remember when we felt the NASDAQ was in severe overvaluation, do you remember when the NASDAQ passed the 3500 level on the way to 5000 and you told us we were obviously wrong on our views of a bubble?" Well, now the NASDAQ has recovered almost 40 % to the 1500 level from the 1250 level. As you can see in an article called " Our Concerns of NASDAQ 5000 ", we were not wrong on our views of the NASDAQ bubble. To answer your question on real estate, we think the financial metrics need to be examined closely before investing. An investor in real estate should exercise the discipline of doubt, understanding of risk, time frame of the investment, historical valuation, cash flow measures and understanding of the specific property and its location.
Lastly Steve, you asked if investors should go into " pure safety." My question back would be, " what is pure safety?” I don't know of any pure safety investment. Of course you are talking about high quality bonds and CDs. High quality bonds have been a material part of our portfolios for the last 12 years (that is how long we have been in this business). One must understand that high quality bonds do have risk. They have risk of rising interest rates (whereas the owner of a bond has a fixed rate of interest), risk of inflation (will your bond pay a greater interest than the inflation rate?), risk of bond being called (if it is a callable bond) and risk of a changing dollar (keep in mind the weak dollar of the last few years). Interest rates are at historic lows as I write this. Hence, the risk of owning high quality Fixed Income Investments has increased (CDs and US Treasuries are traditional Fixed Income Investments). It is not widely known that a change in interest rates can alter the value of a quality bond portfolio. If one invests in a 10 Year Treasury at 3.563 % (rate as I write this) and rates then go to 4.563 %, the loss on value would be approximately 7.50 %.
I think that the answer to your question is that an investor should generally never take hasty action. At the same time, every investor should understand how their investments and cash flow shape their future. Just like in the game of chess, each move should be planned accordingly.
Please feel free to contact us for a free portfolio review. My name is Ronald R. Redfield. Our company’s name is Redfield, Blonsky & Co. Our website is www.rbcpa.com. Our phone number is 908 276 7226.